Issues in Global Management Accounting - Risk

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Issues in Global Management Accounting - Risk

  1. 1. Global Management Accounting The issues that can effect global cost and price decisions. Risk.
  2. 2. Exchange Transaction Risk <ul><li>The greater the proportion of inter-currency exchange transactions to total monetary transactions in a given market, the greater the exposure to changes in exchange rates. If the dollar amount of transactions involving more than one currency is great relative to the total number of transactions the risk is increased. </li></ul><ul><li>Major External Risk Factors </li></ul><ul><li>Foreign currency exchange rates </li></ul><ul><li>Interest rates </li></ul><ul><li>Inflation </li></ul><ul><li>Geo-politics </li></ul>
  3. 3. Adjusting Exposure to Risk <ul><li>Increased exposure to exchange rate occurs when a company has the following items: </li></ul><ul><li>Current assets (not including prepaid expenses) valued in other currencies </li></ul><ul><li>Investments in other currencies </li></ul><ul><li>Long-Term receivables in other currencies </li></ul><ul><li>Companies can lessen their exposure to risk with the following: </li></ul><ul><li>Inventory </li></ul><ul><li>Assets held in their home currency </li></ul><ul><li>Liabilities held in their home currency </li></ul>
  4. 4. Handling Purchasing Risks <ul><li>Companies that have arrangements to purchase foreign commodities at a fixed amount in a foreign currency face exchange rate exposure of a unique type. </li></ul><ul><li>There are three types of arrangements to ease the dollar devaluation on both companies: </li></ul><ul><ul><li>Risk sharing arrangements - Pricing whereby the buyer and seller agree on a formula based on sharing of exchange rate changes. </li></ul></ul><ul><ul><li>Currency matching - The ongoing process of matching cash inflows and outflows by currency per period of time. </li></ul></ul><ul><ul><li>Currency hedging </li></ul></ul>
  5. 5. Types of Risk Exposure <ul><li>There are three types of exposure that multi-national companies must deal with when buying and selling goods: </li></ul><ul><ul><li>Transaction Risk </li></ul></ul><ul><ul><li>Translation Risk </li></ul></ul><ul><ul><li>Economic Risk </li></ul></ul>
  6. 6. Transaction Exposure <ul><li>Transaction exposure is the risk that companies who operate in multiple countries are impacted by changing exchange rates after they have entered into a financial commitment. Examples of transaction exposure include: </li></ul><ul><li>Accounts Payable or Accounts Receivable transactions arising from normal business activity. </li></ul><ul><li>Commitments to buy or lease capital equipment or financing cash flows. </li></ul><ul><li>Prices for raw materials adjusting up or down due to fluctuating exchange rates when there is a significant time window between orders and payments. </li></ul><ul><li>Sales prices denominated in third currencies causing positive or negative effects for a subsidiary that does not control pricing. </li></ul>
  7. 7. Translation Exposure <ul><li>Multi-national firms must periodically re-measure all global operations into a single currency for reporting purposes. By adjusting (or translating) the exchange rates to current rates, the company’s assets, liabilities, equities or income held in different currencies can change in value. </li></ul><ul><ul><li>Under GAAP, income statement and balance sheet exchange rates are set monthly. </li></ul></ul><ul><ul><li>Income statements and balance sheets are converted to the currency of the parent company for financial reporting. </li></ul></ul>
  8. 8. Economic Exposure <ul><li>Aside from existing obligations of the firm which will be settled in foreign currencies at future dates, the firms present value will change as the value of expected future cash flows change as a result of unexpected exchange rate changes. For example, receivables held by subsidiaries in other countries can be affected by rate movement. </li></ul>
  9. 9. Calculating Total Exposure <ul><li>In a global setting, where multiple international operations transact business between many different markets, the transactions exposure of one operation may differ substantially from the exposure of other operations within the enterprise. </li></ul><ul><li>Aggregate transaction exposure of world-wide operations is determined by the consolidation of inter-currency transactions across the entire enterprise. Consolidation on the basis of currency, instead of by location or legal entity, yields a more complete picture of the total currency transactions exposure. </li></ul>
  10. 10. A Short Example… <ul><ul><li>Your business makes a commitment to sell a product made by an international competitor in your domestic market. The price you pay for the product is set in the currency of the competitor. The product becomes a good seller with good margins. The other currency moves up in relation to your home currency, this lowers your margin. Your customers now expect you to deliver this product at a certain price. </li></ul></ul><ul><ul><li>What should you do? </li></ul></ul><ul><ul><li>In this situation, a risk sharing arrangement would probably work best, with both parties absorbing some of the exchange rate fluctuation. </li></ul></ul>

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